Chapter 20 Externalities and Public Goods

Question 1

Explain the effects of a negative externality in a competitive market

Answer 1

A negative externality creates an external cost which is an economic harm. This external cost creates a MSC curve which is equivalent to MC+MEC (marginal cost plus marginal external cost) The MSC curve creates a deadweight loss since firms will produce at S = D but the socially efficient level of output is actually MSC = D

Question 2

Explain the effects of a positive externality in a competitive market

Answer 2

A positive externality creates an external benefit which is an economic gain. This external benefit creates a MSB curve which is equivalent to MB+MEB (marginal benefit plus marginal external benefit) The MSC curve creates a deadweight loss since firms want to produce at the equilibrium (S = D) but it is socially efficient to produce at MSB=S=MC=MSC

Question 3

You know monopolies are less efficient than competition (why again?) but does this still hold true if there is a negative externality involved?

Answer 3

A monopoly can be more efficient (decrease deadweight loss) than competition in some cases, depending on the marginal social cost curve and marginal revenue curve. If, for example, the monopoly produces too much (how does this happen?) the deadweight loss should decrease (show in a graph). The opposite holds true if the monopoly produces too little.

Question 4

What is the purpose of a Pigouvian tax? What about a Pigouvian subsidy?

Answer 4

Pigouvian taxation involves the use of taxes or fees to remedy negative externalities. Pigouvian subsidization, on the other hand, uses subsidies to remedy positive externalities.